Founders of startups must be clear on their exit strategy — the point at which it’s profitable to cash out. If they don’t intend to exit, then it’s best to bypass venture capitalists and look to bank loans.
IF you’re starting a high-growth startup that is scalable to a large enough market (and hence venture-fundable), then you should take exit strategies into consideration.
This is because when venture capitalists (VCs) invest in your startup, they are expecting an average Return on Investment (ROI) timeline of between five and 10 years, for roughly 10 times the original amount they put in.
Assuming that a VC invests US$100,000 into your company in a seed round (usually the second tranche of investment after your initial friends and family or angel round), and your company is being valued at US$500,000 — they would expect your company to exit in, say, seven years, with them making US$1mil, which means that your company’s valuation would have to be worth US$5mil, assuming you’ve not raised additional capital.
If you raised a series A, B and/or C (subsequent rounds of capital) after the seed round, then your equity stake will be diluted because new investors coming in would’ve taken roughly 20% of your total equity with each financing round.
So it would be wise for founders to really consider ahead of time how much to raise for the lifetime of their company and their exit strategy.
For example, the founders may only be left with just 10% of the company after additional rounds of funding, with the company worth say US$100mil. That’s still US$10mil of the company’s wealth — still a life-changing amount.
After all, a small piece of a big pie is better than a big piece of a small pie.
There are some founders who prefer to hang onto ownership rather than raising further capital to grow. Though they may own a large percentage of their company, they may not have the cash and capabilities to compete.
These founders run the risk of dying eventually.
High-growth startup founders need to understand what their VC’s expectations for an exit are when they raise money from them, whether they’d like to build a company where they could eventually publicly list it, or sell it to a larger company via M&A (merger and acquisition).
If you do not intend to exit, then you should not raise VC funding because you may be building a family business that you’ll want to pass on to future generations. Taking out a bank loan may be a more appropriate capital strategy.
To explore potential exit strategies for Malaysian startups, MaGIC did an analysis of past regional exits. In Silicon Valley, we hear of the big firms like Google, Facebook, Airbnb acquiring smaller startups, but where will the M&As in South-East Asia came from?
This is important within the equation of “startup ecosystem building” because without exits, all efforts to spur high-growth startups would not be sustainable because 1) early investors and entrepreneurs would not have liquidity to reinvest their profits into future startups. 2) It would be tough to attract the brightest talent if they don’t see viable exits to justify the risks of leaving a comfortable salaried job.
We’ve observed that in the past decade, 80% of South-East Asia’s Top 10 tech IPOs are from Malaysian founders or Malaysian-based companies. The other 20% are Singaporeans. Malaysian companies prefer to list at the ASX (Australian Security Exchange) because 1) they get better valuations, 2) looser regulatory requirements (biannual versus quarterly reporting, etc), and 3) quicker process than most other exchanges in the world.
On the flip side, when it comes to M&A, Singapore takes lead with 36 acquisitions coming from larger tech firms in the US, while Malaysia is in third place with 12 acquisitions, mostly coming from Australia.
We believe this is because American companies are more comfortable with Singaporean entities, the business environment and the legal system there versus any other country in South-East Asia.
We predict that in the next decade, we will see more post-revenue tech companies preferring to list on the ASX, while most acquisitions of Malaysian startups will come from Japan, Australia and perhaps China. This is because there’s a push for capital to flow, especially out of Japan.
Those who are big enough to acquire smaller startups would Rakuten, Softbank, DeNA, Recruit, etc, from Japan, and potentially Tencent, Alibaba, and Baidu from China.
On the other hand, Australia has always been known as the “marketplace capital” of the world, where companies like Seek, iSelect, CarSales, 99Designs, ThemeForest, etc, thrive. These companies would likely be interested in similarly synergistic marketplaces in South-East Asia to strengthen their position in Apac, perhaps making them better acquisition targets for a US-based large firms, should they themselves choose to exit.
Such is the name of the game in the tech startup and VC world.
The caveat of this article is that the entrepreneur is creating a product of real value to the marketplace with a solid business model, and not merely trying to “flip” the company in an exit, a strategy that historically never works. That said, high-growth entrepreneurs should really consider the type of company they want to build with the desired exit plan, which then corresponds to the type of investors they approach.
Knowing this will provide entrepreneurs clarity and focus in the path ahead, before they jump on the bandwagon of starting a high-growth venture.